Making an investment decision

Value

Investment value: The value determined in view of investment objectives, goals and constraints.

Market value: The price that participants in the market place are willing to pay for the investment, in order to make the investment decision. Market value also represent the anticipated future benefit.

Objectives of real estate investment

Means of building an estatePride of ownershipHedge against inflationDesired rate of return on equity investedDiversification of investor objectivesWealth Maximization

Risk & Return

Risk: is the variation in the expected future benefits.

Return: is the amount inflow generated by an investment each year.– NOI– NOI net of debt payments– After-tax Cash Flows

Rate of return: is measured as percentage per year as relationships between cash flows and amount invested

Real Estate Investment Process

Identify investor’s objectives, Goals, and constraints

Analyze Investment Climate and Market Conditions

Develop Financial AnalysisApply Decision-making CriteriaInvestment Decision

Identifying investor objectives

Each participants have different objectives in real estate investment.

The Equity investor: amount of cash flows from the investment and must be certain of having the legal rights to the cash flows

The Mortgage lender: recovery of the amount lent, as well as in earning a rate of return on the loan.

The Tenant: LeaseThe Government: The relationship among

participants and restrictions on real estate market

Environment for Decision Making

Market Environment: Supply & Demand, Real Estate Sub-market, Population, employment, income, etc.

Legal Environment: Forms of ownership, Land-use control, Limitations on property rights. Community.

Financing Environment: Debt & Equity Financing

Tax environment

Cash Flows Forecasting

Cash outflows from initial investmentCash flows from rent collectionCash flows from assets disposition

Cash Flows Forecasting (cont’)

Potential Gross Income: (PGI)Vacancy and bad debt allowanceEffective Gross Income (EGI)Operating expensesNet Operation Income (NOI)Debt ServiceBefore Tax Cash Flows (BTCF)TaxAfter Tax Cash Flows (ATCF)

Cash Flows From sales of investment

Expected Selling PriceSelling expensesNet sales ProceedsUnpaid Mortgage balanceBefore-tax equity reversionTaxes due on salesAfter-tax equity reversion

Criteria for Decision Making

Rules-of Thumb Techniques: Gross Income Multiplier (GIM), Overall Capitalization (net income multiplier), Equity Dividend

Traditional Appraisal Method: Direct Sales Comparison Approach, Cost Approach, Traditional Income Approach

Discounted Cash Flow (DCF): NPV, IRR